Private Equity vs. Venture Capital: An Overview
Private equity is sometimes confused with venture capital because both refer to firms that invest in companies and exit by selling their investments in equity financing, for example, by holding initial public offerings (IPOs). However, there are significant differences in the way firms involved in the two types of funding conduct business.
Private equity and venture capital (VC) invest in different types and sizes of companies, commit different amounts of money, and claim different percentages of equity in the companies in which they invest.
Key Takeaways:
- Private equity is capital invested in a company or other entity that is not publicly listed or traded.
- Venture capital is funding given to startups or other young businesses that show potential for long-term growth.
- Private equity and venture capital buy different types of companies, invest different amounts of money, and claim different amounts of equity in the companies in which they invest.
Private Equity
Private equity, at its most basic, is equity—shares representing ownership of, or an interest in, an entity—that is not publicly listed or traded. Private equity is a source of investment capital from high-net-worth individualsand firms. These investors buy shares of private companies—or gain control of public companies with the intention of taking them private and ultimately delisting them from public stock exchanges.
Large institutional investors dominate the private equity world, including pension funds and large private equity firms funded by a group ofaccredited investors.
Because the goal is a direct investment in a company, substantial capital is needed, which is why high net worth individuals and firms with deep pockets are involved.
Venture Capital
Venture capital is financing given to startupcompanies and small businesses that are seen as having the potential to generate high rates of growth and above-average returns, often fueled by innovation or by carving out a new industry niche.The funding for this type of financing usually comes from wealthy investors, investment banks, and specialized VC funds. The investment does not have to be financial, but can also be offered via technical or managerial expertise.
Investors providing funds are gambling that the newer company will deliver and will not deteriorate. However, the tradeoff is potentially above-average returns if the company delivers on its potential.
For newer companies or those with a short operating history—two years or less—venture capital funding is both popular and sometimes necessary for raising capital. This is particularly the case if the company does not have access tocapital markets, bank loans, or other debt instruments. A downside for the fledgling company is that the investors often obtain equityin the company and, therefore, a voice in company decisions.
Key Differences
A private equity firm's strategy is to buy mostly buy mature companies that are already established. The companies may be deteriorating or failing to make the profits they should due to inefficiency. Private equity firms buy these companies and streamline operations to increase revenues. Venture capital firms, on the other hand, mostly invest in startups with high growth potential.
Private equity firms mostly buy 100% ownership of the companies in which they invest. As a result, the firm is in total control of the companies after the buyout. Venture capital firms invest in 50% or less of the equity of the companies. Most venture capital firms prefer to spread out their risk and invest in many different companies. If one startup fails, the entire fund in the venture capital firm is not affected substantially.
Private equity firms usually invest $100 million and up in a single company. These firms prefer to concentrate all their efforts on a single company since they invest in already established and mature companies. The chances of absolute losses from such an investment are minimal. Venture capitalists typically spend $10 million or less on each company since they mostly deal with startups with unpredictable chances of failure or success.
Special Considerations
Private equity firms can buy companies from any industry while venture capital firms tend to focus on startups in technology, biotechnology, and clean technology—although not necessarily. Private equity firms also use both cash and debt in their investment, whereas venture capital firms deal with equity only. These observations are common cases. However, there are exceptions to every rule; a firm may act out of the norm compared to its competitors.
Advisor Insight
Rebecca Dawson
President, Dawson Financial, Los Angeles, CA
With private equity, multiple investors’ assets are combined, and these pooled resources are used to acquire parts of a company, or even an entire company. Private equity firms do not maintain ownership for the long term, but rather prepare an exit strategy after several years. Basically, they seek to improve upon an acquired business and then sell it for a profit.
A venture capital firm, on the other hand, invests in a company during its earliest stages of operation. It takes on the risk of providing new businesses with funding so that they can begin producing and earning profits. It is often the startup money provided by venture capitalists that gives new businesses the means to become attractive to private equity buyers or eligible for investment banking services.
Correction—Dec. 2, 2022: A previous version of this article wrongly stated that venture capital firms are limited to startups in technology, biotechnology, and clean technology. In fact, VC firms can work with a broader range of companies and sectors.
FAQs
Private equity involves making controlling investments in distressed companies, with the hopes of making them more profitable. VC, often considered a subset of private equity, refers to making early investments in promising companies (or even ideas) with significant growth potential.
What is the difference between private equity and venture capital? ›
Private equity is capital invested in a company or other entity that is not publicly listed or traded. Venture capital is funding given to startups or other young businesses that show potential for long-term growth.
Do you make more money in VC or PE? ›
Compensation: You'll earn significantly more in private equity at all levels because fund sizes are bigger, meaning the management fees are higher. The Founders of huge PE firms like Blackstone and KKR might earn in the hundreds of millions USD each year, but that would be unheard of at any venture capital firm.
Is Shark Tank VC or PE? ›
The sharks are venture capitalists, meaning they are "self-made" millionaires and billionaires seeking lucrative business investment opportunities. While they are paid cast members of the show, they do rely on their own wealth in order to invest in the entrepreneurs' products and services.
What is the difference between private equity hedge funds and venture capital? ›
Private equity firms invest in mature companies with stable cash flows, while venture capital firms invest in new or emerging companies with high growth potential. Hedge funds invest in various financial instruments and use different strategies to generate returns for their clients.
What is venture capital in simple words? ›
What is venture capital in simple words? Venture capital is money invested in a business, usually a start-up, that is seen as having strong growth potential. It is typically provided by investors who expect to receive a high return on their investment.
What is an example of private equity? ›
There are several well-known private equity firms, including: Apollo Global Management (APO), which owns brands such as Cox Media Group and CareerBuilder. Blackstone Group (BX) invests in real estate private equity and healthcare, including Service King and Crown Resorts.
Which is riskier VC or PE? ›
Private equity is typically considered less risky than venture capital. It involves investment in less volatile industries and focuses on later-stage businesses. However, both are still risky endeavors, and private equity requires significantly more money than venture capital.
Why PE is better than VC? ›
Another key difference between the two is venture capital “typically involves higher risk but offers the potential for substantial returns,” says Zhao. In comparison, private equity “usually involves lower risk compared to VC investments but may offer more modest returns.”
Can I move from VC to PE? ›
Transitioning from venture capital to private equity requires a significant shift in mindset and skillset. To be successful in private equity, you'll need to develop a deep understanding of how to evaluate established companies, perform due diligence, and manage risk.
High-net-worth individuals (HNWI), insurance companies, pension funds, foundations, and corporate pension funds may pool money in a fund controlled by a VC firm. The venture capital firm acts as the general partner (GP), while the other companies or individuals are LPs. All partners have part ownership of the fund.
How does PE differ from VC? ›
What is venture capital? Technically, venture capital (VC) is a form of private equity. The main difference is that while private equity investors prefer stable companies, VC investors usually come in during the startup phase. Venture capital is usually given to small companies with incredible growth potential.
Are hedge funds private? ›
A hedge fund is a limited partnership of private investors whose money is pooled and managed by professional fund managers. These managers use a wide range of strategies, including leverage (borrowed money) and the trading of non-traditional assets, to earn above-average investment returns.
Is BlackRock private equity? ›
BlackRock's private equity advantage
BlackRock Private Equity Partners (PEP) taps into the firm's robust sourcing channels to seek out high quality opportunities across all market cycles. PEP has $48.5 billion AUM and a 23+ year track record invested across direct and secondary investments.
Is BlackRock a hedge fund? ›
BlackRock manages US$38bn across a broad range of hedge fund strategies. With over 20 years of proven experience, the depth and breadth of our platform has evolved into a comprehensive toolkit of 30+ strategies.
Is Berkshire Hathaway a hedge fund? ›
Because Berkshire is a publicly traded holding company, rather than a mutual fund or hedge fund, it doesn't charge fees. And Buffett never had to worry that investors would flood him with too much money at a market top or yank it out at the bottom. Most funds have fickle capital; Berkshire has permanent capital.
What is an LP in venture capital? ›
In venture capital, limited partners or LPs are entities or individuals who contribute capital to VC funds. LPs invest in the fund's corpus with the expectation of generating returns from the fund's investments in various startups and high-growth companies.
Is venture capital only for private companies? ›
Venture capital is also a way in which the private and public sectors can construct an institution that systematically creates business networks for the new firms and industries so that they can progress and develop.
What does private equity do? ›
Getting started in a profession in private equity (PE) requires strong analytical and networking skills to jumpstart a career at a PE firm. Private equity operates with investors and uses funds to invest in private companies or buy out public companies.
How much do you get paid in private equity? ›
Private Equity Salary, Bonus, and Carried Interest Levels: The Full Guide
| Position Title | Typical Age Range | Base Salary + Bonus (USD) |
|---|
| Associate | 24-28 | $150-$300K |
| Senior Associate | 26-32 | $250-$400K |
| Vice President (VP) | 30-35 | $350-$500K |
| Director or Principal | 33-39 | $500-$800K |
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